To Scalp or not to Scalp? That is the question

Introduction

Scalping is a term, which is not often mentioned in many of the forex glossaries, so I thought that I would write about it here, which has actually come about as a question, which was posed to me the other day, on this topic, over a beer, with some friends. We all had our various thoughts and nothing seemed really conclusive. So, why, I ask myself, was that? I feel that, the answer here is relatively simple; in so much that I have always said, “That there is not one strategy, which fits all, with forex.” At least, on that point, we all agreed and went onto finish our beers and the evening.

The question was; are there really any advantages to using this method? Now a smart ass answer would be, “That there are advantages and disadvantages, in every method,” which at worst, is a purely smart ass answer and a bit of a cop-out answer and at best, – which really does not address the question at all.

Moreover, it seems to me that not too many (especially novice) traders actually know what it is at all – at least in the financial sense of the word. In this short article, I will attempt to address this issue.

What is scalping?

Well a quick “Google,” will come up with some results, occupying the first top places, on the first page – namely the removal of someone’s’ scalp; after he/she’s been killed, which was largely practiced both Europeans and the Native Americans alike. Well, it is definitely not that, I am glad to say. However, it does, to a point involve some very surgical, if you’ll excuse the pun, movements.

Scalping is, in a nutshell, is a tactic used by some people (called, in the business, Scalpers), who make their trades; in and out of the market on small – even very small fluctuations in prices. Now this, as a rule, involves the quick liquidation of positions – usually within the same day, hour or even just a few minutes.

But what does this actually mean, to the uninitiated and what does it all require? Scalping is a trading style, which specialises, as mentioned (above), taking profits on small price changes – soon after the trade has been entered and become profitable. But what does this actually require, from the trader?

It requires a very, very, strict discipline on his/her exit strategy; as one large loss could eliminate any gains made on the smaller scales. It also requires having the right tools to hand, such as a good trading platform, a good Internet connection – allowing direct access to the broker. And, last but not least, an element of stamina – to place as many trades as is required for the strategy to be even remotely successful.

Based on the assumption that most stocks will complete the first stage of a movement; bearing in mind that a stock will move, in the desired direction – albeit for a brief period of time. However, where it goes after that is not so certain – some stocks will cease to advance, whilst others will continue. A scalper will tend to take as many profits as possible; not allowing them to dissipate/evaporate, into thin air.

This approach is in direct contrast to the, “let profits your run,” notion, which attempts to optimise positive trading results by increasing the size of winning trades while letting others reverse – meaning that scalping achieves the results, by sacrificing the size of the wins.

Having said that, it is not unusual for a trader for a trader (with a longer time frame period), to achieve good results by winning only half or even less of his or her trades – it's just that the wins are much bigger than the losses. A successful scalper, however, will have a much higher ratio of winning trades versus losing ones while keeping profits roughly equal or slightly bigger than loss.

What is a Scalper?

A scalper is speculator, who trades in and out of the market on very small price fluctuations. The scalper, trading in this manner, provides market liquidity but not often carries an overnight position.

To scalp

To scalp (and here it is, indeed, a verb), means to trade for small gains, which normally involves establishing and liquidating a position quickly, usually within the same day, hour or even just a few minutes.

The three main types of scalping

Market Scalping: this is where a scalper will try to capitalise on the spread. Here he or she will do this or attempt to do this by simultaneously posting a bid on a specific stock. This can only be successful on immobile stocks that trade large volumes without any significant price changes. This is not by any means easy, because a trader is competing with market makers, for the shares on both bids and offers. Moreover, the profit is small – so small, infact, that any stock movement against the trader’s position, could result in a loss; against his or her original target profit.

The second type of scalping is: achieved by purchasing large numbers of shares. These are sold for gain – on very small price movements. Using this approach to trading, a trader will enter into positions for several thousand shares and then wait for any small movement (usually measured in cents), which requires a very high liquid stock – to facilitate entering and exiting 3,000 – 10,000 shares, with ease.

The third type of scalping is: arguably considered to be the closest to traditional methods of trading. Meaning that a trader enters an amount of shares (on any setup or signal from his or her system), and then closes the position as soon as the first exit signal is generated near the 1:1 risk/reward ratio, calculated as described earlier.

There are three main reasons for scalping

One is for less risk exposure, which means that a brief exposure, to the market lessens the possibility of running into adverse events.

Smaller moves are easier to achieve, meaning that a larger supply and demand imbalance is required to warrant bigger changes in price. I.e. it is easier for a stock to make a ten cent move, than opposed to a one dollar move

Logically speaking – smaller moves happen far more frequently than that of larger movements, and even when the markets are fairly quiet, a good scalper can exploit the many small movements.

The different types of scalping

One way is called a Primary Style, whereby a scalper will make a number of different trades a day – anything from between say: five – hundreds, using one minute charts; because the time frame on these is small and a trader needs to see any happening events in real time and as they are coming through and shaping up.

Another is called a Supplementary Style, which means that traders, using other time frames, can use scalping as a supplementary tool – in a variety of different ways. The most obvious way to use it is when the market is either choppy or in narrow range lock, where there are no trends, in a longer time-frame, can reveal any visible and/or exploitable trends, which can lead a trader to scalp.

There is also the Umbrella Concept, which allows a trader to improve his/her cost basis and maximise profits. The umbrella concept works something like this:

A shorter time-frame is initiated by the trader.

Traders identify new setups, in a shorter space of time, in the direction of the main trade – exiting and entering (or vice-versa) them based on the scalping principles.

Conclusion

Used as a primary strategy, scalping can be effective – even for those who use it for supplementary strategy. However, again one has to be strict wit one’s self and keep to strict exit plans, which is key to making small profits into large gains. The reason for its popularity is the very brief amount of market exposure and the frequency of small moves, which are its main attributes; and it is fir these reasons why this strategy is quite popular with many types of market traders.

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